Asia Pacific produces nearly half the world’s greenhouse gas emissions, according to a 2023 World Economic Forum white paper, making it an important contributor to global efforts to meet the goals of the Paris Agreement. Clearly, Asia Pacific economies must decarbonise – although this should be done in as fair and just a manner as possible.
For investors who invest in APAC, this means their investments are exposed to potential transition risk (i.e., making current and future business models compatible with decarbonisation policies) and physical risk (i.e., damages from physical events exacerbated by climate change).
Already, Asia has experienced more extreme weather events than other regions, based on a study by Asian Infrastructure Investment Bank. Yet, investors face challenges in understanding the extent of the risks their investments face such as diverging regulatory standards when it comes to risk disclosure and unharmonised datasets for detailed analysis. They must also consider the various stages at which economies in APAC are growing and the impact this has on emissions.
Assessing the scope of emissions
To be able to assess the transition risk in our investments, we rely on greenhouse gas emissions disclosures by the companies we invest in. GHG emissions comprise scope 1 direct emissions, scope 2 indirect emissions, and scope 3 value chain emissions.
We believe scope 3 emissions can provide powerful insights into the risks around the energy transition. Simply put, they can help us to understand the emissions exposure of products and services and the potential impact on margins, cash flow, and profitability if carbon pricing was introduced.
Already, the EU has implemented the Carbon Border Adjustment Mechanism where exporters of primary goods such as steel to Europe face a carbon price adjustment on their goods depending on the emissions of their products. This will affect APAC companies that export goods to Europe.
However, scope 3 emissions disclosures are patchy in APAC. We must rely on industry-level estimates to gauge this risk. New data products and service providers are attempting to bridge this gap and deliver better information.
International reporting bodies such as the International Sustainability Standards Board have published reporting standards to harmonise disclosures globally. We expect regulators in APAC to adopt these standards soon, which should improve the understanding of emissions exposures.
Green bonds and sustainability labelled bonds
While we focus on risks, we must not forget that there are investment opportunities too. Green bonds and sustainability labelled bonds are examples of investments enabling investors to direct capital to climate solutions and earn a market return (because these bonds usually rank pari passu to conventional bonds of the same issuer, and they all bear the same issuer credit risk).
However, applying only the lens of emissions exposure may not sufficiently capture how these investments contribute towards environmental objectives. For example, if a green bond finances a solar renewable power asset, this asset will still produce GHG emissions during its lifecycle (though admittedly much less so than a fossil fuel power asset).
The asset could also be assessed on the basis of avoided emissions. This involves measuring the difference in emissions between a renewable power asset and a fossil fuel based one.
By understanding the extent of avoided emissions, we know which product and service is more likely to advance decarbonisation. Investments in green bonds can use avoided emissions to demonstrate how they contribute to environmental objectives, in addition to understanding the emissions exposure from a risk perspective.
We discussed these points in a recent webinar hosted by Environmental Finance. For the recording, visit https://register.gotowebinar.com/recording/2050243277507109888.
